Ireland: An Ideal Location For Intellectual Property Securitisation

The value in companies derived from intangibles and intellectual
property has increased substantially in recent years. Surprisingly,
that value is often not properly recognized or used. However,
companies can use revenue streams from IP to raise cash to fund
operations, expand, or even address pension deficits by isolating
IP and issuing securities backed by the cash flows (IP
securitization). This article examines some of the tax,
structuring, and commercial considerations involved in IP
securitization.

IP Securitization

IP rights vest ownership in the creators and owners of
inventions, products, or brands and prevent others from using them
without the creator's consent, and may also be used to prevent
a third party from creating or using something similar. The main
rights that lend themselves to securitization are patents,
trademarks, and copyright.

Typically, some companies in a corporate group will hold IP
rights (IP Holdco) while others in the group or third parties pay
royalties or license fees to use that IP. This income stream can be
sold to a newly formed special purpose vehicle (SPV), thus creating
cash for immediate use by the group. The SPV raises the cash by
issuing bonds to investors backed by the IP cash flows. A typical
structure is illustrated in the figure. There is flexibility in
structuring. The SPV might be a group company or an
''orphan'' with its shares held in a charitable
trust. The SPV does not need to own the IP outright as long as it
has the right to the IP income streams.

Different series or tranches of bonds may be issued to respond
to investor demand for different maturities and credit qualities.
The tranching and pricing of the bonds are based on an analysis of
the reliability and predictability of the timing and amount of the
revenue streams transferred to the SPV, and on senior or
subordinated structures or financial guarantees from the corporate
group or third parties.

Examples

The first major transaction to securitize IP was in 1997 when
singer David Bowie raised $55 million by securitizing royalties
from his back catalog. Royalty Pharma, a U.S. company, structured a
securitization issuing $225 million in AAA-rated bonds backed by
biopharmaceutical patents in 2003. From 2005 to 2007, companies
such as Dunkin' Brands, Quiznos, Sears Holdings Corp., IHOP,
and Domino's Pizza established IP-based securitizations backed
by trademark and franchise royalties ranging from $200 million to
$1.85 billion. Vertex Pharmaceuticals issued a $240 million
securitization in July 2009 from which investors were repaid from
license payments regarding the drug Telaprevir. Morgan Stanley has
advised on 18 pharmaceutical-based securitizations since 2004.

Advantages

Securitization has several benefits. It allows a longterm income
stream to be converted into cash for immediate use and allows IP
asset risk to be transferred to capital markets investors. It also
can create tax efficiencies for the group and can facilitate the
strategic management of a group's IP that might otherwise be
held in different companies or jurisdictions. If properly
structured, the sale to an SPV can be without recourse so that any
ultimate default in the bonds should not affect the credit strength
of the group itself.

Funding Pension Deficits

The credit crunch and recession have led to cash and credit
restrictions for many companies. Many are now reviewing balance
sheets and trying to use alternative assets to fund their pension
commitments. Pension trustees are increasingly willing to take
patents, trademarks, and copyright as security against pension
liabilities, thus reducing the cash contribution required and
potentially improving overall balance sheet values. In a typical
structure, IP assets would be retained within the group, sometimes
using limited partnerships as vehicles, isolating the IP and its
income for the benefit of the company's pension fund. This
benefits both the fund (which may see an immediate reduction in the
pension deficit) and the company (which might see its pension
contributions reduce without losing any actual assets). This
structure was recently adopted by TUI Travel PLC in the U.K.

Commercial Risks

Investors in IP-backed securities should be aware of some of the
risks before committing themselves. For example, who would have
predicted that peer-to-peer Internet file sharing would initially
have had such a significant effect on music royalty income? There
is a general risk with old technology that it will become obsolete
and a risk with new technology that it will be undervalued when it
is securitized. Drug patent royalties may be adversely affected if
the drug is the subject of lawsuits, regulatory restrictions, or
withdrawal from the market. Moreover, there is no global IP law
— if the assets are located or covered by rules in multiple
jurisdictions, then this could increase the due diligence required
and thus increase the costs of the transaction.

What Works?

The ideal IP to securitize is substantial, diverse, nonvolatile,
and with strong cash flows. To minimize risk, a broad range of IP
income streams should be included in the SPV's asset pool.

One of the big successes is film. Copyright-protected films are
a protectable, substantial IP right that may accrue strong cash
flows through licensing or franchising. Music is definitely back on
the agenda with the growth of mainstream music purchasing sites
like iTunes and Spotify, and since music publishers have finally
got the upper hand against illegal file-sharers. Sports are another
popular target. The biggest growth area might be pharmaceuticals,
in which manufacturers could fund the massive investment needed to
develop new drugs by securitizing future license fees.

Ireland and IP Securitization

Ireland has a special tax regime designed to facilitate
securitization transactions. An Irish issuer, funded wholly by
debt, can hold qualifying assets in a taxneutral manner. IP income
streams are qualifying assets. The underlying IP, while not itself
qualifying, will either be structured to be ancillary to managing
the income and thus permissible within the legislation, or else
would be retained in the corporate group or in another company and
thus outside the issuer.

Investors can subscribe for different series of bonds, and, most
importantly for tax purposes, a subordinated bond can also be
issued (typically to the sponsor) that pays out an amount equal to
the profit left in the issuer after paying other bondholders and
costs. The return is fully deductible if properly structured,
thereby minimizing any residual corporate tax in Ireland and
avoiding the need for complex deferred payment mechanisms. An
issuer would typically be an orphan company with its shares held in
a charitable trust and its assets held in a security trust for the
benefit of the bondholders. To achieve Irish tax residence, an
issuer must have a majority of Irish resident directors (typically
two). However, it does not have to be incorporated in Ireland. For
example, many Irish resident issuers are incorporated in the Cayman
Islands, which can have company law and insolvency benefits while
at the same time the tax benefits of being an Irish tax resident
company.

The bonds can be listed on an exchange such as the Irish Stock
Exchange. If so, interest can generally be paid free of withholding
tax to investors wherever resident. However, if the bonds are not
listed, the beneficial owner of the interest must be resident in an
EU or tax treaty state where the interest is subject to tax and
not, for example, regarded as an exempt distribution, or else be a
tax-exempt entity in such a jurisdiction. Ireland has income tax
treaties with 70 countries, including all the major trading
economies, so this is a limited restriction on the investor base in
practice. An Irish issuer is a fully taxable Irish limited company
and generally entitled to the benefits of Ireland's treaty
network. This gives Ireland an advantage in facilitating
transactions in a mobile global asset such as IP. IP royalties
payable to the Irish issuer from any country with which Ireland has
an income tax treaty should benefit from the royalty article in
that treaty if there were any withholding in the source country and
subject to the rules of that source country.

Securitizing U.S. Royalties Through Ireland

Ireland is a particularly suitable jurisdiction to securitize
U.S. IP. In this regard, the combination of a qualifying investor
fund (Qualifying Investor Alternative Investment Fund, or QIAIF)
with a section 110 company may be attractive and has been used in
the past. A QIAIF is a regulated fund, typically taking the form of
a company or unit trust that is exempt from tax on income and gains
and can pay returns, free of withholding, to investors wherever
resident. A QIAIF is regarded as Irish resident for purposes of the
Ireland-U.S. income tax treaty, which means that as long as the
requirements of the limitation on benefits article is also met,
several structuring possibilities can be considered.

Ireland as an IP Hub

Ireland is a major European and global platform for a host of
U.S. and other multinationals, with a particular concentration in
technology, social media, and pharmaceuticals. It is also a member
of the EU and OECD and the only English-speaking member of the
eurozone. This gives it a unique advantage over many other
competing jurisdictions. U.S. multinationals in particular have
considerable experience working within the Irish legal and tax
system and, equally important, Irish firms and advisers have
experience with the requirements of the U.S. system.

Crucially, Ireland also has one of the best statutory frameworks
for IP in the world. All the core Irish legislation regarding
trademarks, patents, copyright, and related rights have been
recently introduced. On the level of enforcement, Ireland has the
advantage of a dedicated commercial court and IP disputes forum,
which has radically reduced the time in which major IP cases are
resolved, from three years on average to less than one year.

Conclusion

Given the sheer value of IP on company balance sheets, the
opportunity exists to turn this to cash to finance and grow the
business and to provide a good investment return in a low-yield
environment. A significant number of IP securitizations have been
completed recently, some publicly rated and others closed
privately. They include securitizations of music and film
royalties, trademark royalties, and patent royalties. As an EU
jurisdiction with strong IP protection laws, a tried and tested
securitization regime, and wide tax treaty network, Ireland is an
ideal location to facilitate those transactions.

Originally published in Tax Notes Int'l, May 19,
2014, p. 651

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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A Securitisation Cell Company (SCC) is a company constituted or converted as such and creating within itself one or more cells for the purposes of segregating and protecting the cellular assets of the company.

On 30 December 2014 the Ministry of Financial Services published its Consultation Report on the Maintenance of Legal and Beneficial Ownership Information. The next step in this process is today’s publication of submissions received during the consultation.

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